Every investor would love to stumble upon the perfect stock. But will you ever really find a stock that provides everything you could possibly want?
One thing's for sure: You'll never discover truly great investments unless you actively look for them. Let's discuss the ideal qualities of a perfect stock, then decide if Rent-A-Center (Nasdaq: RCII ) fits the bill.
The quest for perfection
Stocks that look great based on one factor may prove horrible elsewhere, making due diligence a crucial part of your investing research. The best stocks excel in many different areas, including these important factors:
- Growth. Expanding businesses show healthy revenue growth. While past growth is no guarantee that revenue will keep rising, it's certainly a better sign than a stagnant top line.
- Margins. Higher sales mean nothing if a company can't produce profits from them. Strong margins ensure that company can turn revenue into profit.
- Balance sheet. At debt-laden companies, banks and bondholders compete with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
- Money-making opportunities. Return on equity helps measure how well a company is finding opportunities to turn its resources into profitable business endeavors.
- Valuation. You can't afford to pay too much for even the best companies. By using normalized figures, you can see how a stock's simple earnings multiple fits into a longer-term context.
- Dividends. For tangible proof of profits, a check to shareholders every three months can't be beat. Companies with solid dividends and strong commitments to increasing payouts treat shareholders well.
With those factors in mind, let's take a closer look at Rent-A-Center.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||3.5%||Fail|
|1-Year Revenue Growth > 12%||1.8%||Fail|
|Margins||Gross Margin > 35%||16.2%||Fail|
|Net Margin > 15%||5.6%||Fail|
|Balance Sheet||Debt to Equity < 50%||48.2%||Pass|
|Current Ratio > 1.3||0.53||Fail|
|Opportunities||Return on Equity > 15%||11.5%||Fail|
|Valuation||Normalized P/E < 20||9.77||Pass|
|Dividends||Current Yield > 2%||2.4%||Pass|
|5-Year Dividend Growth > 10%||NM||NM|
|Total Score||3 out of 9|
Source: Capital IQ, a division of Standard & Poor's. NM = not meaningful; Rent-A-Center paid its first dividend in August 2010. Total score = number of passes.
With only three points, Rent-A-Center still has perfection on layaway. The company's business seems tailor-made for tough times, but so far, Rent-A-Center hasn't converted on its opportunity.
Rent-A-Center leases out furniture, home electronics, and other high-ticket consumer goods to households that either can't afford or don't want to buy outright using conventional financing. With the recession having tightened up credit standards, Rent-A-Center's business model lets some customers get things they otherwise wouldn't have a chance to buy. Moreover, just as companies like United Rentals (NYSE: URI ) and RSC Holdings (NYSE: RRR ) give homeowners access to industrial equipment that they wouldn't want to own outright, Rent-A-Center gives its customers the choice to avoid the hassles and expense of full ownership.
One challenge Rent-A-Center faces is strong competition. Aaron's (NYSE: AAN ) not only has a similar business, but has also posted much faster growth. Moreover, Rent-A-Center's recent financial performance hasn't been very good. In its second-quarter earnings report, revenue and earnings were less than expected, and the company pushed its guidance for 2011 down as well.
In a low-margin, highly competitive business, Rent-A-Center may never become a perfect stock. If the company can't thrive during tough times like today's economic environment, it's hard to imagine how it will thrive once more consumers have enough money to start making big purchases again.
No stock is a sure thing, but some stocks are a lot closer to perfect than others. By looking for the perfect stock, you'll go a long way toward improving your investing prowess and learning how to separate out the best investments from the rest.
Click here to add Rent-A-Center to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.